Today the Office of Pharmacy Affairs (“OPA”) of the Health Resources Services Administration (“HRSA”) published in the Federal Register its first proposed regulation under the 340B Drug Discount Program since the Program was established in 1992. This Program, authorized under section 340B of the Public Health Service Act, requires manufacturers who execute a Pharmaceutical Pricing Agreement with the government to sell covered outpatient drugs to specified categories of covered entities at a price that does not exceed a statutory ceiling price. Execution of the agreement is a condition for the federal government to pay for the manufacturer’s covered outpatient drugs under Medicaid and Medicare Part B. The specified covered entities are several categories of clinics that receive federal grants as well as certain hospitals that serve low income populations. HRSA has published guidance to implement the 340B Program, but has never before issued a regulation.

The Patient Protection and Affordable Care Act of 2010 ("ACA") made a number of changes to the 340B Program, including the addition of several types of hospitals to the list of eligible covered entities. Beyond disproportionate share hospitals and children’s hospitals, which were eligible covered entities before the ACA was enacted, the ACA expanded the program to include free-standing cancer hospitals, critical access hospitals, rural referral centers, and sole community hospitals. However, the ACA also contained an exception under which these new types of covered entity hospitals are precluded from obtaining 340B discounts for “a drug designated by the Secretary . . . for a rare disease or condition” – i.e., for a drug designated by the FDA as an orphan drug. OPA’s proposed rule implements this restriction.

Interpretation of the statutory orphan drug exclusion is not as straightforward as it might seem, because many drugs are designated as orphan for certain indications but are also approved and/or prescribed for other, non-orphan indications. Should a drug that has an orphan designation for one but not all of its indications be ineligible for 340B discounting, even if a hospital purchases it to use for a non-orphan use? HRSA has decided no, and proposed an approach under which exclusion depends on the indication for which such a drug is used. The proposed rule provides that, for the new categories of hospitals, a covered outpatient drug subject to 340B discounts does not include an orphan drug that is “transferred, prescribed, sold, or otherwise used for the rare condition or disease for which the drug was designated” as an orphan, but an orphan drug that is transferred, prescribed, sold, or otherwise used for a non-orphan indication is subject is 340B pricing. This use-based approach is apparently HRSA’s attempt to balance the intent of the 340B program to provide low-cost drugs to hospitals serving low-income patients against the Congressional intent not to undermine pricing for drugs used to treat rare diseases. However, there are several problems with HRSA’s interpretation.

First, it is inconsistent with the statutory language, which excludes a “drug” – not an “indication” – that has obtained an orphan designation from the FDA. In addition, implementation of this rule would rely on the honor system. Under the proposal, the responsibility rests with the hospital to ensure that orphan drugs purchased at the 340B price will not be prescribed or used for a non-orphan condition. See proposed 42 C.F.R. § 10.21(c). This is to be done by maintaining separate purchasing accounts, improving inventory and auditing capacity, and maintaining auditable records, which must be provided at the request of the government or a manufacturer. The preamble makes clear that a manufacturer may not condition sales upon receiving prior assurance that the 340B drug will not be used to treat a rare disease or condition.

Reliance on an honor system to implement the orphan drug exclusion might be acceptable if OPA had the resources to conduct compliance audits of covered entities. However, the OPA is notoriously underfunded and understaffed (an OPA official reported at a conference in March that OPA then had a staff of 15), and is unlikely to implement any routine auditing program in the foreseeable future. Moreover, the statute does not authorize manufacturers to audit covered entities for compliance with the orphan drug exclusion (though it does authorize manufacturer audits of compliance with other 340B Program requirements). The proposed regulation does refer to “government-approved manufacturer audits.” However, such audits are expensive, particularly for orphan drug manufacturers, which tend to be smaller companies. Even putting aside the cost of an audit, they are unlikely to be undertaken absent evidence of gross over-purchasing, so smaler-scale violations will go undetected.

There is an alternative that does not rely on an honor system that is unlikely to be enforced. That is to do as the statute mandates, and exclude “a drug designated [by the FDA] for a rare disease or condition,” even if the drug may have non-orphan indications. Comments on the proposal must be submitted by July 19, 2011.